[mike_terror]

Hi guys, I’ve been thinking about a problem for revenue recognition all morning and it’s driving me nuts! Maybe I’m just over thinking, but I hope someone can help me out here.

You recognize revenue when it is realized or relizable and earned. If it has been realized but not earned, then it is considered deferred revenue. So for example, if you are a health gym and you sell yearly memberships for $100 a year in advance….. your deferred revenue (unearned revenue) is $100 until you actually start providing the services correct?

Revenue is another word for “sales” is it not?

Now here comes the part where I am confused. When talking about a company selling equipment and accounting for the sale under installment method….. the revenue recognized now deals with “gross profit”. So why is gross profit involved when the question is asking for the revenue recognized for the year? (The health gym example didn’t have to deal with gross profit)

I’m confused because in the example with the health gym, if they ask for the revenue recognized for the year, “gross profit” is not involved, you only play with the SALES number. The SALES number is what the customer is paying. Why isn’t this the same case when dealing with the installment method. If I’m selling machinery under the installment method, how come my revenue recognized isn’t based off of the sales amount, but instead “gross profit”.

In a question that I was trying to solve, company A sells customer B machinery. Then question was asking “What total amount of revenue should Mill recognize from the sale of machinery and financing?”. When I read this, saw “revenue”, all I thought about was the sales amount.

AHH! I hope I’m making sense with my question and someone can chime in. It’s 6:58am in the morning and I’m going insane here.

[jenuno01]

@mike – your assumptions and logic are correct. However, I get a feel that you're not reading the question right or are missing something, usually when the Installment method is used, the problem will specify it. Keep in mind that the Installment method is a cash-basis method used when the ultimate collectibility of the sales is doubtful…

Class of 2012

[mike_terror]

Hi jenuno, the question that I was doing did specify that that the installment method was used. I'm just confused as to why “gross profit” plays in part in the revenue recognition when this method is being used. Is this just a rule we must accept? When they ask about revenue recognition, I automatically think of the “sales number” and how much of that to recognize based on what is earned, but since the installment method is used, does this mean gross profit MUST play a role?

Also, here is a problem that I've made up. If I sell a machine for $100, and my carrying amount was $30, my gross profit is $70 with a 70% GP rate. Let's say at the very end, I receive $100 in cash from my customer. I will only be recognizing 70% of this $100 as gross profit realized / recognized. What about my other $30? How would you journalize this from beginning to end?

[Anonymous]

Mike_terror, is this a REG or FAR question?

[mike_terror]

@ CPA-Convertible, sorry I forgot to mention this, but it is for FAR

[jenuno01]

When you use the Installment method you recognize a portion of revenue every year according to the cash you collect during the year. The deferred amount is based on the ending Accounts Receivable balance. Below is an excerpt from my notes. Hope this helps:

* The installment sales method is used only when installment sales are material and there's no reasonable basis for estimating collectability. Under the installment method, total GP is deferred until cash payments are received. Realized GP equals the GP % times the ratio of cash received to the total sale amount

Gross profit %= Sales – CGS / Sales

GP % * End A/R = Deferred GP

GP % * Cash collected = Realized GP

The cost recovery method is used when there's not reasonable basis for estimating collectability

Class of 2012

[mike_terror]

@jenuno, thank you for your reply. I do understand your notes, but my question still remains about what happens with the rest of the revenue.

From your notes, “When you use the Installment method you recognize a portion of revenue every year according to the cash you collect during the year.” Even after collecting all the cash, the only portion you are recognizing is the gross profit, but what about the rest of the sales amount?

[Anonymous]

Mike, i think for Installment sales method, the CPA exam is only testing you on whether you can find the % of G/P to be realized as revenue for the current period, the amount of cash that was collected in said period, the A/R balance at the end of the year, or % of deferred G/P balance at the end of the period.

You don't need to worry about how to book the rest of the sales amount. It's usually just categorized as A/R

[Author]

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